A Test on Stock-picking Skills and Its Application to Active Mutual Funds

I develop a powerful test to evaluate individual investor's stock-picking skills by constructing counterfactual return distributions as the benchmark. The test leverages information in portfolio holdings to examine the entire distribution of investor's performance and develops robustness to stochastic volatility and benchmark mis-specification. When applied to the cross section of active mutual funds, the test is able to identify a time-varying group of funds that are able to generate a before-fees (after-fees) four-factor alpha of 428 bps (292 bps) per year. The identified outperforming funds are small in size, hold concentrated portfolios and attract more flows controlling for alpha